Pat Hanley thought he'd heard the last of Centis, an office-supply company that had been his customer for years before it filed for bankruptcy in 2002. But last September, Hanley, the 64-year-old owner of North Central Pallets in Argos, Ind., received a letter from Centis' bankruptcy lawyers demanding that hanley return all the money Centis had paid him in the 90 days before it went bust. Worse, he got a similar letter the same month from the lawyers of another now-bankrupt client. The tally: $8,825 from Centis, based in Brea, Calif., and $13,559 from Morgan Marshall Industries, a shelving manufacturer in Chicago Heights, Ill.
Hanley was outraged. After all, his $10 million, 35-employee company had held up its end of the deals, delivering pallets to both customers on time. "I wasn't going to roll over and play dead with these lawyers using lawsuits and courts as a weapon," he says. Hanley dashed off letters to the courts handling the cases. Much to his surprise, the Santa Ana (Calif.) judge handling Centis dismissed the suit. Hanley is still waiting for a response from the Chicago bankruptcy court.
Most business owners are not as lucky as Hanley, but thousands are facing similar demands as bankruptcy lawyers target smaller companies for so-called preference actions. The suits seek to recover payments made by companies just before they file for bankruptcy. The bankruptcy code says no creditor is entitled to preferential treatment -- and anyone who gets paid in the 90 days before a company goes under is considered "preferred."
As more businesses keep electronic payment records, it becomes easier for lawyers to decide who to sue and more worthwhile to chase smaller payments. The number of preference suits almost doubled, to about 55,000, from 2001 to 2004, says the Administrative Office of the U.S. Courts.
If you receive a demand letter, make sure the payments cited are accurate and that they occurred in the 90 days before the bankruptcy filing. If so, you have three defenses: First, if you were paid in cash, you may not be considered a creditor. Second, under the "new value exception," you can try to prove that the payments were for previous sales and that you haven't been paid for more recent work. Finally, you can try to show that the payments were made in the "ordinary course of business" -- part of a long-standing pattern of payments.
Most businesses are wise to settle. It's nearly impossible to fight these cases without a lawyer, and you may need to defend yourself in a jurisdiction far from home. But that doesn't mean you shouldn't argue for better terms. And who knows? Like Hanley, you just might have a judge who sees things your way.
By Pallavi Gogoi